The Benefits and Preferred Methods for Index Option Trading
One of the primary benefits that distinguishes index option trading, is that the price action is much more stable than it is for individual stocks. The shares of an individual company may unpredictably skyrocket or plummet overnight as a result of breaking news such as an earnings report, a change in executive management, an unforeseen disaster or new discovery. But this type of price action is very rare with indices.
The simple reason for this, is that because indexes are comprised of many stocks, the impact of one individual company on the whole is minimal. A possible exception to this may be a major player in the Dow Jones Industrial Index rising or falling by more than 10 percent in one day – since only 30 companies form its repertoire. But by and large, the other indexes such as the S&P500, the Russell 2000 and the Nasdaq 100 include so many top companies that it takes a major economic shift in the overall market to make an impression.
The other feature about index option trading, is that indexes and their associated Exchange Traded Funds (ETFs) are a highly liquid financial instrument. The volume and open interest in indexes, particularly ETFs that are aligned with them, is constantly growing. This means positions are easily entered and exited, usually without much slippage. For this reason, traders are able to take advantage of broad market moves and tailor their option trading strategies to suit.
Why ETF’s Are Preferred For Index Option Trading
Let’s say you wanted to trade the S&P500 index and at the time of your decision, the SPX is trading around 1330 points. You believe that by next month’s expiry date in 45 days, it will fall to around 1250. You could purchase put 1300 options on the SPX but at that price level, each option contract would cost you about $28.70. Just one contract would cost you $2,870.
On the other hand, you could consider buying put options in the SPY, which is an ETF whose portfolio of stocks is a weighted average of all the companies that make up the S&P500. This means that price movements in the SPY track those of the S&P500 index. Looking at put options for the SPY with 45 days to expiration, the price for one contract is only $2.86 which is about 10 percent that of the index itself. Not only that, but whereas the open interest on the S&P500 1330 puts at the time of writing is 3,289 … the OI on the SPY 133 puts is 41,638.
See why ETFs are more attractive?
Not only is the liquidity unquestionably greater, but since the options are also much cheaper, you have much more flexibility in terms of how many contracts you wish to purchase according to whatever trading capital you have. This may be particularly significant if you are using a strategy which requires you to adjust or add to, your existing positions.
Trading Binary Index Options
Binary options are a relatively new and an increasingly popular mode of options trading because the concept behind it is simple – you either get paid a nice profit (usually about 70 percent) or you don’t. There are no complex options formulas, implied volatility or time decay elements to worry about. It’s just a simple matter of getting your prediction right or wrong – that’s the binary part.
Binary options cover a number of major indexes around the world.
The Best Index Option Trading Strategies
We have already established that index options are far less susceptible to unpredicably volatile behaviour. This makes them a prime candidate for range trading option strategies. There is one certainty about options and that is, that they will eventually expire – and during the last month before expiration their out-of-the-money time value (theta) decreases exponentially. If you understand how powerful this factor is, you can craft an almost risk free, low stress, index option trading strategy that just keeps on serving your profits month after month.
If you would like to know more about how you can do this, take a look at the Options Trading Pro System. I love it! Why? Because it just keeps on working – and if you do it according to the instructions, you can expect around 50 percent return on risk each month. You need to “paper trade” for a few months so that you fully grasp all the elements of the strategy and how to implement them. The broker and trading platform they recommend includes that facility. But once you’ve “got it” – after that, it’s just a question of “how much money do you want to make?”